Statement of Cash Flows 16 Statement of Cash Flows

After studying this chapter, you should be able to: Summarize the types of cash flow activities reported in the statement of cash flows. Prepare a statement of cash flows, using the indirect method. Prepare a statement of cash flows, using the direct method.

16-1 Objective 1 Summarize the types of cash flow activities reported in the statement of cash flows.

16-1 The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends.

Reporting Cash Flows 16-1 The statement of cash flows reports cash flows from three types of activities: 1. Cash flows from operating activities are cash flows from transactions that affect net income. 2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets. 3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

Statement of Cash Flows—NetSolutions 16-1 6

Sources (increases) of Cash Uses (decreases) of Cash Exhibit 2 Cash Flows 16-1 Sources (increases) of Cash Uses (decreases) of Cash (receipts from revenues) Operating (payments for expenses) Operating (receipts from sales of noncurrent assets) Investing (payments for acquiring noncurrent assets) Investing (receipts from issuing equity and debt securities) Financing (payments for treasury stock, dividends, and redemption of debt securities) Financing 7

Cash Flows from Operating Activities 16-1 The direct method reports the sources of operating cash and the uses of operating cash. 8

16-1 The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash. 9

16-1 Cash inflows from operating activities normally arise when cash is received from customers. Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages.

16-1 A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in the statement of cash flow. A primary disadvantage of the direct method is that the necessary data may not be readily available and may be costly to gather.

16-1 A primary advantage of the indirect method is that it focuses on the differences between net income and cash flows from operations. Because the data are readily available, another advantage of the indirect method is that it is normally less costly to use than the direct method.

Cash Flows from Operations: Direct and Indirect Methods— NetSolutions 3 16-1 same amount 13

Cash Flows from Investing Activities 16-1 Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets. Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

Cash Flows from Financing Activities 16-1 Cash inflows from financing activities normally arise from issuing debt or equity securities. Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

Noncash Investing and Financing Activities 16-1 Noncash investing and financing activities are transactions that do not involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

16-1 I M P O R T A N T The financial statements, including the statement of cash flows, should not report cash flow per share.

Purchase treasury stock Depreciation expense 16-1 Example Exercise 16-1 For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method. Purchase patent Pay cash dividend Disposal of equipment Net income Purchase treasury stock Depreciation expense 18

Investing Financing Operating Financing Follow My Example 16-1 16-1 Follow My Example 16-1 Investing Financing Operating Financing For Practice: PE 16-1A, PE 16-1B 19

Prepare a statement of cash flows, using the indirect method. 16-2 Objective 2 Prepare a statement of cash flows, using the indirect method.

16-2 An efficient approach to preparing the statement of cash flows is to analyze the changes in the noncash balance sheet accounts. The logic of this approach is that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance sheet accounts.

16-2 The analysis of Retained Earnings provides a good starting point for determining the cash flows from operating activities, which is the first section of the statement of cash flows.

Comparative Balance Sheet 16-2 Comparative Balance Sheet 23 (Continued)

Comparative Balance Sheet 16-2 Comparative Balance Sheet 24 (Concluded)

Retained Earnings 16-2 The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year. ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00 25

16-2 The net income of $108,000 is entered on the statement (or working papers). ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00 To statement 26

Cash flows from operating activities: Net income $108,000 Operating Activities— Rundell Inc. 16-2 Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: This phrase is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations. 27 18

Depreciation 16-2 Next, we need to determine depreciation expense for the year. If it isn’t given in the income statement, sometimes it can be found by analyzing the various accumulated depreciation accounts.

16-2 The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry. ACCOUNT Accumulated Depreciation—Building ACCT. NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 58,300.00 Dec. 31 Depr. for year 7,000.00 65,300.00 to statement 29

16-2 The offsetting $7,000 debit is to an expense for depreciation. The effect on the income statement was to reduced net income; however, this expense did not require an outflow of cash. Therefore, the $7,000 is added back to net income in determining cash flows from operating activities.

Amortization is treated in the same manner as depreciation. Operating Activities—Rundell Inc. 16-2 Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Amortization is treated in the same manner as depreciation. 31

Gain on Sale of Land 16-2 The ledger or income statement of Rundell Inc. indicates that the sale of land resulted in a gain of $12,000. This gain increased net income by $12,000, yet cash flows was provided by an investing activity (selling land) rather than an operating activity, so the gain is deducted from net income on the statement of cash flows.

Cash flows from operating activities: Net income $108,000 Operating Activities—Rundell Inc. 16-2 Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) 33

16-2 Example Exercise 16-2 Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities. 34

Adjustments to reconcile net income from operating activities: 16-2 Follow My Example 16-2 Net income $50,000 Adjustments to reconcile net income from operating activities: Depreciation 12,000 Amortization 3,400 Gain on sale of land (4,100) Net cash flow from operating activities $61,300 For Practice: PE 16-2A, PE 16-2B 35

Changes in Current Operating Assets and Liabilities 16-2 Next, select current assets and current liabilities that impact cash flows and determine their increases and decreases. Exhibit 5 in the next slide my prove to be helpful in determining how to treat increases and decreases in noncash current operating assets and current operating liabilities.

Adjustments to Net Income (Loss) Using the Indirect Method 16-2 Adjustments to Net Income (Loss) Using the Indirect Method 16-2 37

Changes in Current Accounts 16-2 Changes in Current Accounts December 31 Increase Accounts 2008 2007 Decrease* Accounts receivable (net) $ 74,000 $ 65,000 Inventories 172,000 180,000 Accounts payable (mdse.) 43,500 46,700 Accrued expenses payable 26,500 24,300 Income taxes payable 7,900 8,400 9,000 8,000* 3,200* 2,200 500* Note that Cash and Dividends Payable are not included in this analysis. 38

Cash flows from operating activities: Net income $108,000 Operating Activities—Indirect Method 16-2 Cash flows from operating activities: Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) Changes in current operating assets and liabilities: Increase in accounts receivable (9,000) Decrease in inventory 8,000 Decrease in accounts payable (3,200) Increase in accrued expenses 2,200 Decrease in income taxes payable (500) 39 You will notice that increases actually decrease cash flows from operating activities, and decreases do just the opposite.

Same information as Slide 39, only in final form. 16-2 16-2 Statement of Cash Flows—Indirect Method for Rundell Inc. (Operating Activities Section) 40 Same information as Slide 39, only in final form.

16-2 Example Exercise 16-3 Victor Corporation’s comparative balance sheet for current assets and current liabilities was as follows: Dec. 31, 2009 Dec. 31, 2008 Accounts receivable $ 6,500 $ 4,900 Inventory 12,300 15,000 Accounts payable 4,800 5,200 Dividends payable 5,000 4,000 Adjust net income of $70,000 for changes in operating assets and liabilities. 41

Increase in accounts receivable (1,600) Decrease in inventory 2,700 16-2 Follow My Example 16-3 Net income $70,000 Adjustments to reconcile net income to net cash from from operating activities: Increase in accounts receivable (1,600) Decrease in inventory 2,700 Decrease in accounts payable (400) Net cash flow from operating activities $70,700 For Practice: PE 16-3A, PE 16-3B 42

Omicron, Inc. reported the following data: 16-2 Example Exercise 16-4 Omicron, Inc. reported the following data: Net income $120,000 Depreciation expense 12,000 Loss on disposal of equipment 15,000 Increase in Accounts receivable 5,000 Decrease in Accounts payable (2,000) Prepare the cash flow for operating activities section of the statement of cash flows using the indirect method. 43

Cash flows from operating activities: 16-2 Follow My Example 16-4 Cash flows from operating activities: Net income $120,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 12,000 Loss from disposal of equipment 15,000 Changes in current operating assets and liabilities: Increase in accounts receivable (5,000) Decrease in accounts payable (2,000) Net cash flow from operating activities $140,000 44 For Practice: PE 16-4A, PE 16-4B

Cash Flows Used for Payment of Dividends 16-2 ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 10,000 10 Cash paid 10,000 — June 20 Dividends declared 14,000 14,000 July 10 Cash paid 14,000 — Dec. 20 Dividends declared 14,000 14,000 Note that while $28,000 in dividends were declared, only $24,000 were paid during the year. 45

16-2 Because paying of dividends affects equity and is an outflow of cash, it is a negative $24,000 cash flows from financing activities transaction.

Common Stock increased by $8,000. Common Stock 16-2 Common Stock increased by $8,000. ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 16,000 Nov. 1 4,000 shares issued/cash 8,000 24,000 47

16-2 Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000. ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 80,000 Nov. 1 4,000 shares issued/cash 40,000 120,000 48

16-2 Issuing common stock affects equity; therefore, we have a positive $48,000 cash flows from financing activities item.

Bonds Payable decreased by $50,000. Bonds Payable 16-2 Bonds Payable decreased by $50,000. ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 150,000 June 30 Retired by payment of cash at face amount 50,000 100,000 50

16-2 Retiring bonds is a cash outflow reported as a negative item under cash flows from financing activities.

Building 16-2 By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash. ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 200,000 Dec. 27 Purchased for cash 60,000 260,000 52

16-2 Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activity.

Land 16-2 The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase. ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 125,000 June 8 Sold for $72,000 cash 60,000 65,000 Oct. 12 Purchased for $15,000 cash 15,000 80,000

16-2 The first transaction, the sale of land, is classified as a positive cash flows from investing activity because land is a noncash asset.

16-2 The $12,000 gain was recorded earlier on Slide 34 as an operating activity. The purchase of land also is an investing activity. Click the button to view Slide 34. To return to this slide, type “56” and press the “Enter” key.

16-2 The second transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the cash flows from investing activities section.

16-2 Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement) 58

The ending balance in the Cash account should match this amount. 16-2 Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement) The ending balance in the Cash account should match this amount. 59

16-2 Example Exercise 16-5 Alpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions are reported on the statement of cash flows? 60

The gain on sale of land is deducted from net income as shown below: 16-2 Follow My Example 16-5 The gain on sale of land is deducted from net income as shown below: Gain on sale of land $(35,000) Cash received for sale of land $200,000 Cash paid for purchase of land (125,000) The purchase and sale of land is reported as part of cash inflow form investing activities as shown below: 61 For Practice: PE 16-5A, PE 16-5B

Prepare a statement of cash flows, using the direct method. 16-3 Objective 3 Prepare a statement of cash flows, using the direct method.

The Direct Method 16-3 The final amount for cash flows from operating activities will be the same whether the direct or indirect approach is used. The methods differ in how the data are obtained, analyzed, and reported.

Schedule of Changes in Current Accounts Exhibit 8 Data for Direct Method 16-3 Rundell Inc. Schedule of Changes in Current Accounts December 31 Increase Accounts 2008 2007 Decrease* Cash $ 97,500 $ 26,000 $71,500 Accounts receivable (net) 74,000 65,000 9,000 Inventories 172,000 180,000 8,000* Accounts payable (merchandise creditors) 43,500 46,700 3,200* Accrued expenses payable (operating expenses) 26,500 24,300 2,200 Income taxes payable 7,900 8,400 500* Dividends payable 14,000 10,000 4,000 64 (Continued)

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 16-3 (Concluded) 65

Cash Received from Customers 16-3 The $1,180,000 of sales for Rundell Inc. is reported using the accrual method. An adjustment is necessary to convert the sales reported on the income statement to the cash method.

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Received from Customers 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash received from customers Changes Sales $1,180,000 Increase in accounts rec. (9,000) Cash received from customers $1,171,000 67

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Received from Customers 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 Cash received from customers Changes Sales $1,180,000 Increase in accounts rec. (9,000) Cash received from customers $1,171,000 68

Add decrease in accounts receivable 8,000 16-3 Example Exercise 16-6 Sales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received from customers. Follow My Example 16-6 Sales $350,000 Add decrease in accounts receivable 8,000 Cash received from customer $358,000 69 For Practice: PE 16-6A, PE 16-6B

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Payments for Merchandise 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 Cash payments for merchandise Changes Cost of merchandise sold $790,000 70

Rundell Inc. Income Statement For the Year Ended December 31, 2008 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 Cash payments for merchandise Changes Cost of merchandise sold $790,000 Decrease in inventories (8,000) Decrease in accounts payable 3,200 Cash payments for merchandise $785,200 71

Rundell Inc. Income Statement For the Year Ended December 31, 2008 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) Cost of merchandise sold Changes Cash payments for merchandise Decrease in inventories (8,000) Decrease in accounts payable 3,200 Cash payments for merchandise $785,200 $790,000 72

Cost of merchandise sold $145,000 Add increase in inventories 9,000 16-3 Example Exercise 16-7 Cost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year. Determine the amount of cash paid for merchandise. Follow My Example 16-7 Cost of merchandise sold $145,000 Add increase in inventories 9,000 Deduct increase in accounts payable (4,000) Cash payments for merchandise $150,000 73 For Practice: PE 16-7A, PE 16-7B

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Payments for Operating Expenses 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) 74

Rundell Inc. Income Statement For the Year Ended December 31, 2008 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) There is no cash flow for depreciation expense. 75

Rundell Inc. Income Statement For the Year Ended December 31, 2008 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) (193,800) Cash payments for operating expenses Changes Changes Operating expenses (other than depreciation) $196,000 Increase in accrued expenses (2,200) Cash payments for operating expenses $193,800 76

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Gain on Sale of Land 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 The gain on sale of land of $12,000 is included in the proceeds from the sale of land, which is reported as part of cash flows from investing activities. (785,200) (193,800) To avoid confusion, page numbers for the remaining slides are centered on the slides. 77

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Gain on Sale of Land 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) Cash paid for interest expense Changes Interest expense 8,000 (193,800) +/- decrease/increase in payable 0 Cash payments for interest $8,000 (8,000) 78

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Payments for Income Taxes 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) Cash payments for income taxes Changes Income tax expense (193,800) $83,000 Add decrease in income taxes payable 500 Cash payments for income tax $83,500 (8,000) (83,500) 79

Rundell Inc. Income Statement For the Year Ended December 31, 2008 Cash Payments for Income Taxes 16-3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 Other expense: Interest expense 8,000 4,000 Income before income tax $ 191,000 Income tax 83,000 Net income $ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2008 CASH BASIS $1,171,000 (785,200) (193,800) (8,000) (83,500) 80 $ 100,500

16-3 Statement of Cash Flows—Direct Method (Operating Activities Section) 81

A reconciliation is required when the direct method is used. Statement of Cash Flows—Direct Method (Reconciliation) 16-3 A reconciliation is required when the direct method is used. 82

Financial Analysis and Interpretation 16-3 Free cash flow is a measure of operating cash flow available for corporate purposes after providing sufficient fixed asset additions to maintain current productive capacity and dividends.

Cash flow from operations Less: Investments in fixed assets to Free Cash Flow 16-3 Cash flow from operations Less: Investments in fixed assets to maintain current production Free cash flow Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and enjoy financial flexibility.